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This is all you need to take away from the article... > Bond mutual and exchange-traded funds now own 17% of all corporate bonds, up from 9% in 2008, according

This is all you need to take away from the article... > Bond mutual and exchange-traded funds now own 17% of all corporate bonds, up from 9% in 2008, according to the ICI. In periods of market stress, more-concentrated mutual-fund ownership tends to mean larger price drops, the IMF said last year. It used to be the case that stocks, bonds and other commodities like gold has inverse correlations. Or in other terms, when stocks were down, bonds and gold were up.... This lead to the Efficient Frontier from Markowitz where you would choose a risk level you were comfortable with and then build a portfolio of "uncorrelated assets" to get you optimum return for your risk level. http://www.investopedia.com/terms/e/efficientfrontier.asp http://www.investopedia.com/terms/e/efficientfrontier.asp The issue now a days is that this no longer makes much sense as when things go wrong everything is correlated almost to a degree of 1. Or in other terms, when the shit hits the fan, everything (Gold, stocks and bonds) all go down together. TL/DR the old advice about investing in both bonds, stocks and gold for diversivication of risk is at best much less pronounced than it used to be and at worst just bad advice as they are now positively correlated.

tinkerrr 11y ago
> It used to be the case that stocks, bonds and other commodities like gold has inverse correlations Where are you getting this information, on which the whole comment is based? It has always been very volatile and stocks and bonds have almost never been "uncorrelated assets". They change sign very frequently. Here's a research report from PIMCO [1] that shows the change in sign of the correlation to be 29 times in the past 90-odd years. https://media.pimco.com/Documents/PIMCO_Quantitative_Research_Stock_Bond_Correlation_Oct2013.pdf https://media.pimco.com/Documents/PIMCO_Quantitative_Researc...
- toomuchtodo 11y ago
  I found several resources online confirming OPs statement when I googled "stocks bonds inverse correlation". Also, while only anecdotal, my father had told me that rule as well, and he spent about a decade in the pit trading commodities on the CME in Chicago (hogs, corn, soy, with some t-bills for good measure).
  - tinkerrr 11y ago
    I am sorry, I provided a research report in the link. I think it makes more sense to follow that rather than a person's word who traded commodities, commenting on bonds-stocks correlation for a decade without empirical data. The bottom line is, there are many periods of time when stocks and bonds are inversely correlated and many times when there is a positive correlation. That's the whole point.
    - toomuchtodo 11y ago
      > The bottom line is, there are many periods of time when stocks and bonds are inversely correlated and many times when there is a positive correlation. That's the whole point. This is a gross simplification. Historically, to the 1930s, stocks and bonds were inversely correlated. Only recently has that behavior not held true (around 2008, according to the very PIMCO paper you cited). To put it simply, it all comes down to interest rates. The only reason stocks and bonds are no longer inversely correlated (in my opinion) is the Fed's QE efforts. Historically, funds would move between stock and bond asset classes based on market sentiment (stocks when bullish, bonds when bearish). Now, with an excess of cheap funds available (thanks QE!), both asset classes are being inflated artificially. http://www.rba.gov.au/publications/bulletin/2014/sep/pdf/bu-0914-8.pdf http://www.rba.gov.au/publications/bulletin/2014/sep/pdf/bu-... http://blogs.wsj.com/moneybeat/2013/07/25/why-arent-stocks-and-bonds-moving-in-opposite-direction/ http://blogs.wsj.com/moneybeat/2013/07/25/why-arent-stocks-a... http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2014/05/29/a-guide-to-the-relationship-between-bonds-and-interest-rates http://money.usnews.com/money/blogs/the-smarter-mutual-fund-... http://www.bloomberg.com/news/articles/2014-08-26/something-s-out-of-whack-with-bonds-stocks-bianco-sees-losses http://www.bloomberg.com/news/articles/2014-08-26/something-... http://time.com/money/3981692/what-the-bond-market-says-about-stocks-and-vice-versa/ http://time.com/money/3981692/what-the-bond-market-says-abou...
      - tosseraccount 11y ago
        Aggregate bonds vs.stocks (EAFE and US) : < -0.4 for last three months according to this ... http://www.assetcorrelation.com/majors http://www.assetcorrelation.com/majors
- bgilroy26 11y ago
  First bulletpoint in your cited article reads: >In the short run, stocks and bonds tend to run in opposite directions to fluctuations in investor risk appetite I take this excerpt to mean that Pimco shares the same "common wisdom" assumption that Chollida1 does
  - hueving 11y ago
    risk appetite isn't the same thing as price correlation.
    - bgilroy26 11y ago
      "Stocks" in that quote is short hand for "stock prices". When Tinkerrr's cited paper says that "stocks and bonds tend to run in opposite directions" they are saying they have a negative price correlation.
- jmalicki 11y ago
  To the long-term investor, the correlation changing sign very frequently is very similar to "uncorrelated"
caminante 11y ago
Through this post and others of yours, I've become a fan of your financial insight. Any recommendations on financial literature that unpacks this further?
tosseraccount 11y ago
"everything is correlated almost to a degree of 1" Nonsense. Evidence : https://www.portfoliovisualizer.com/asset-class-correlations https://www.portfoliovisualizer.com/asset-class-correlations ( 2009-2015 time period ) Example: VTI and TLT (total stocks vs. total bonds) has -0.34 correlation.
- nkassis 11y ago
  Is there similar data for longer periods of time? Seems like it be interesting to see that correlation in periods that include some recessions or am I completely off the mark?
  - roymurdock 11y ago
    Figure 2 illustrates five-year correlations between monthly U.S. stock and U.S. bond total returns over five-year intervals since 1926 (17 distinct, nonoverlapping periods). While the long-term average correlation between these two asset classes has been 0.25, the figure shows that correlations over shorter windows vary widely from this average, with a range of 0.72 for the five years ended 1975 to –0.54 for the five years ended 2005. http://www.vanguard.com/pdf/s130.pdf http://www.vanguard.com/pdf/s130.pdf
- AnimalMuppet 11y ago
  Sure - for the 2009-2015 time period. But the claim was not "everything is correlated almost to a degree of 1". The actual claim was "when things go wrong everything is correlated almost to a degree of 1". Look at the data from 2008, not 2009-2015.
  - tosseraccount 11y ago
    Do you have a link for 2008? He said "... bad advice as they are now positively correlated."
    - AnimalMuppet 11y ago
      No. I heard it as a common, repeated observation about 2008, but I don't have a link to actual data.
dovereconomics 11y ago
While investors look for gold and bonds as a response to falling equities, they're actually just trying to find 'safety'. That doesn't tell anything about which asset they'll necessarily choose. Take the EM crisis we've been experiencing. Yes, everything going downhill, but many EM investors bought USD as a 'response'. If USD has problems, maybe certain commodities go up. It's hard to tell.
lisper 11y ago
> everything (Gold, stocks and bonds) all go down together That's not possible. At the very least, cash cannot "go down" along with everything else. If everything is down then, by definition, cash is up because you can now buy more of everything with the same amount of cash.
- aidenn0 11y ago
  There was a massive loss in wealth across most asset classes during the last crash without any significant price deflation, so I feel like this is empirically not true. Yes, if you held cash in 2007, you beat the market, but you weren't wealthier than you were the year before.
  - msandford 11y ago
    If you sold everything in 2007 and re-bought in 2009 you're substantially wealthier now than you were in 2007. So in that way, cash appreciated (relative to assets) during the crash of 2008. During that time period the numbers in your bank account didn't get any bigger. But if that were the sole qualification for "increasing wealth" then the folks constantly worried about deflation are totally wrong!
    - aidenn0 11y ago
      I was using consumer-goods purchasing power as an estimate of wealth. It is obvious that if you can time the market you can make more than if you can't time the market. However, until someone seriously suggests keeping a significant fraction of your investment portfolio as cash (preferentially to e.g. bonds) as a hedge against market crashes, I don't think it makes sense to classify cash as an investment instrument.
      - lisper 11y ago
        http://money.cnn.com/2013/11/06/investing/wealthy-investors-cash/ http://money.cnn.com/2013/11/06/investing/wealthy-investors-...
      - 11y ago
roymurdock 11y ago
Would it be fair to say that diversification of a portfolio is only advantageous when there are relatively few others diversifying as well? Or is it an issue of inequality - too few investing firms owning/managing too many assets? Are the markets just so efficient that assets that once had clearly distinct risk/reward profiles are now blending together?
shostack 11y ago
So given the huge push towards buying index funds and the general Bogleheads approach, does this just mean Main St. investors are setting themselves up to be trampled again when equities drop if bonds follow suit? Is there even a good hedge available for Joe Investor and his 401k?
Natsu 11y ago
Doesn't building portfolios like that correlate the previously uncorrelated risks?

tinkerrr 11y ago

> It used to be the case that stocks, bonds and other commodities like gold has inverse correlations Where are you getting this information, on which the whole comment is based? It has always been very volatile and stocks and bonds have almost never been "uncorrelated assets". They change sign very frequently. Here's a research report from PIMCO [1] that shows the change in sign of the correlation to be 29 times in the past 90-odd years. https://media.pimco.com/Documents/PIMCO_Quantitative_Research_Stock_Bond_Correlation_Oct2013.pdf https://media.pimco.com/Documents/PIMCO_Quantitative_Researc...

toomuchtodo 11y ago
I found several resources online confirming OPs statement when I googled "stocks bonds inverse correlation". Also, while only anecdotal, my father had told me that rule as well, and he spent about a decade in the pit trading commodities on the CME in Chicago (hogs, corn, soy, with some t-bills for good measure).
- tinkerrr 11y ago
  I am sorry, I provided a research report in the link. I think it makes more sense to follow that rather than a person's word who traded commodities, commenting on bonds-stocks correlation for a decade without empirical data. The bottom line is, there are many periods of time when stocks and bonds are inversely correlated and many times when there is a positive correlation. That's the whole point.
  - toomuchtodo 11y ago
    > The bottom line is, there are many periods of time when stocks and bonds are inversely correlated and many times when there is a positive correlation. That's the whole point. This is a gross simplification. Historically, to the 1930s, stocks and bonds were inversely correlated. Only recently has that behavior not held true (around 2008, according to the very PIMCO paper you cited). To put it simply, it all comes down to interest rates. The only reason stocks and bonds are no longer inversely correlated (in my opinion) is the Fed's QE efforts. Historically, funds would move between stock and bond asset classes based on market sentiment (stocks when bullish, bonds when bearish). Now, with an excess of cheap funds available (thanks QE!), both asset classes are being inflated artificially. http://www.rba.gov.au/publications/bulletin/2014/sep/pdf/bu-0914-8.pdf http://www.rba.gov.au/publications/bulletin/2014/sep/pdf/bu-... http://blogs.wsj.com/moneybeat/2013/07/25/why-arent-stocks-and-bonds-moving-in-opposite-direction/ http://blogs.wsj.com/moneybeat/2013/07/25/why-arent-stocks-a... http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2014/05/29/a-guide-to-the-relationship-between-bonds-and-interest-rates http://money.usnews.com/money/blogs/the-smarter-mutual-fund-... http://www.bloomberg.com/news/articles/2014-08-26/something-s-out-of-whack-with-bonds-stocks-bianco-sees-losses http://www.bloomberg.com/news/articles/2014-08-26/something-... http://time.com/money/3981692/what-the-bond-market-says-about-stocks-and-vice-versa/ http://time.com/money/3981692/what-the-bond-market-says-abou...
    - tosseraccount 11y ago
      Aggregate bonds vs.stocks (EAFE and US) : < -0.4 for last three months according to this ... http://www.assetcorrelation.com/majors http://www.assetcorrelation.com/majors
bgilroy26 11y ago
First bulletpoint in your cited article reads: >In the short run, stocks and bonds tend to run in opposite directions to fluctuations in investor risk appetite I take this excerpt to mean that Pimco shares the same "common wisdom" assumption that Chollida1 does
- hueving 11y ago
  risk appetite isn't the same thing as price correlation.
  - bgilroy26 11y ago
    "Stocks" in that quote is short hand for "stock prices". When Tinkerrr's cited paper says that "stocks and bonds tend to run in opposite directions" they are saying they have a negative price correlation.
jmalicki 11y ago
To the long-term investor, the correlation changing sign very frequently is very similar to "uncorrelated"

caminante 11y ago

Through this post and others of yours, I've become a fan of your financial insight. Any recommendations on financial literature that unpacks this further?

tosseraccount 11y ago

"everything is correlated almost to a degree of 1" Nonsense. Evidence : https://www.portfoliovisualizer.com/asset-class-correlations https://www.portfoliovisualizer.com/asset-class-correlations ( 2009-2015 time period ) Example: VTI and TLT (total stocks vs. total bonds) has -0.34 correlation.

nkassis 11y ago
Is there similar data for longer periods of time? Seems like it be interesting to see that correlation in periods that include some recessions or am I completely off the mark?
- roymurdock 11y ago
  Figure 2 illustrates five-year correlations between monthly U.S. stock and U.S. bond total returns over five-year intervals since 1926 (17 distinct, nonoverlapping periods). While the long-term average correlation between these two asset classes has been 0.25, the figure shows that correlations over shorter windows vary widely from this average, with a range of 0.72 for the five years ended 1975 to –0.54 for the five years ended 2005. http://www.vanguard.com/pdf/s130.pdf http://www.vanguard.com/pdf/s130.pdf
AnimalMuppet 11y ago
Sure - for the 2009-2015 time period. But the claim was not "everything is correlated almost to a degree of 1". The actual claim was "when things go wrong everything is correlated almost to a degree of 1". Look at the data from 2008, not 2009-2015.
- tosseraccount 11y ago
  Do you have a link for 2008? He said "... bad advice as they are now positively correlated."
  - AnimalMuppet 11y ago
    No. I heard it as a common, repeated observation about 2008, but I don't have a link to actual data.

dovereconomics 11y ago

While investors look for gold and bonds as a response to falling equities, they're actually just trying to find 'safety'. That doesn't tell anything about which asset they'll necessarily choose. Take the EM crisis we've been experiencing. Yes, everything going downhill, but many EM investors bought USD as a 'response'. If USD has problems, maybe certain commodities go up. It's hard to tell.

lisper 11y ago

> everything (Gold, stocks and bonds) all go down together That's not possible. At the very least, cash cannot "go down" along with everything else. If everything is down then, by definition, cash is up because you can now buy more of everything with the same amount of cash.

aidenn0 11y ago
There was a massive loss in wealth across most asset classes during the last crash without any significant price deflation, so I feel like this is empirically not true. Yes, if you held cash in 2007, you beat the market, but you weren't wealthier than you were the year before.
- msandford 11y ago
  If you sold everything in 2007 and re-bought in 2009 you're substantially wealthier now than you were in 2007. So in that way, cash appreciated (relative to assets) during the crash of 2008. During that time period the numbers in your bank account didn't get any bigger. But if that were the sole qualification for "increasing wealth" then the folks constantly worried about deflation are totally wrong!
  - aidenn0 11y ago
    I was using consumer-goods purchasing power as an estimate of wealth. It is obvious that if you can time the market you can make more than if you can't time the market. However, until someone seriously suggests keeping a significant fraction of your investment portfolio as cash (preferentially to e.g. bonds) as a hedge against market crashes, I don't think it makes sense to classify cash as an investment instrument.
    - lisper 11y ago
      http://money.cnn.com/2013/11/06/investing/wealthy-investors-cash/ http://money.cnn.com/2013/11/06/investing/wealthy-investors-...
    - 11y ago

roymurdock 11y ago

Would it be fair to say that diversification of a portfolio is only advantageous when there are relatively few others diversifying as well? Or is it an issue of inequality - too few investing firms owning/managing too many assets? Are the markets just so efficient that assets that once had clearly distinct risk/reward profiles are now blending together?

shostack 11y ago

So given the huge push towards buying index funds and the general Bogleheads approach, does this just mean Main St. investors are setting themselves up to be trampled again when equities drop if bonds follow suit? Is there even a good hedge available for Joe Investor and his 401k?

Natsu 11y ago

Doesn't building portfolios like that correlate the previously uncorrelated risks?